Greek Cypriot MPs are battling to prevent their island state from crashing out of the euro as the country's banks remained closed and demonstrators rallied outside parliament.

The hopes of politicians on the island had been pinned on a rescue package from Russia, but with the Cypriot finance minister Michalis Sarris returning empty-handed after two days of talks in Moscow, the race to secure a bailout from the EU and IMF has now intensified.

Cyprus needs €17bn (£14.5bn), and is in negotiations to get €10bn from the EU, the IMF and the European Central Bank. The remainder must come from the country's own resources. The original bailout plan, announced last Saturday, would have raised €5.8bn by skimming nearly 7% off all bank deposits of less than €100,000, and 9.9% of bigger bank accounts. A package of austerity measures was also planned to take the total to €17bn.

Sarris returned with the news no one wanted: the controversial bank tax must now be put back on the agenda.

"I think that it is clearly on the table, that it is something that needs to be discussed to see whether a levy on deposits of some sort … would make a contribution to finalising the package," he said.

It was expected that the levy will focus only on accounts with more than €100,000 – but that threatens to stoke tensions with Moscow. Russian investors have €17bn deposited in Cyprus accounts – the island is a tax haven – and the initial plan provoked anger at the highest levels of government in Russia.

President Nicos Anastasiades had proposed that small savers be included for fear of driving away the Russians, whose deposits are vital to keep the Cyprus banking system afloat. The Russian government has also already extended a €2.5bn loan to Nicosia, which the Cyprus government needs to retain.

The volte-face on the bank levy followed mounting criticism of MPs for rejecting the first bailout accord in the first place. Prominent former MPs accused the island's political elite of pandering to populist sentiment in the maelstrom of outrage that the proposal triggered. Critics said that, had the levy been passed, the government would not have been forced to draw up alternative plans. They now include the restructuring of the island's second biggest bank, Laiki, a move that its CEO, Takis Phidias, described as a "disaster not just for the bank but for the economy of Cyprus". The basic plan is to split the bank in two.

The reappearance of the levy came after Germany's chancellor, Angela Merkel, also rejected an alternative scheme of a solidarity fund proposed by Anastasiades's government. Another alternative considered is to combine hypothetical returns from offshore gas and oil reserves; to nationalise Cypriot workers' pension funds; and to skim revenue from Cypriot Orthodox church assets to raise the cash that Nicosia needs to qualify for €10bn in aid.

George Vassiliou, the former president of Cyprus, told the Guardian it was imperative that the banking system was not allowed to collapse.

"Cyprus is not just an island in the sun," he said. "We have developed a unique service sector based on confidence in the banking system. If that confidence is lost then you have nothing left. Everything that has been created will be destroyed with formidable repercussions."

The 82-year-old added: "The most pressing priority is to ensure that Cyprus gets help but also, more importantly, that the confidence of foreigners and depositors is restored in its banking system."

He said there was "no doubt" that ordinary people should contribute to the island's financial rescue. But he criticised the lack of foresight the euro group ministers had shown in announcing the levy.

MPs on Friday spent frantic hours tweaking legislation that would satisfy Berlin, the ECB and the IMF, and the Nicosia parliament was sitting on Friday night, although a key vote on part of the new bailout plan could be delayed until this morning.

Merkel has adopted a tough stance. She told German MPs that the Mediterranean island's business model was obsolete and that the bailout would need to be structured in such a way that it could be repaid. Cyprus, she said, could no longer depend on its reputation as an offshore tax haven.

Greece also weighed in, announcing that its local lender, Piraeus Bank, would buy branches of Laiki and the Bank of Cyprus in Greece. The move came as officials in Athens expressed consternation over Germany's apparent determination to cut Cyprus loose if need be.

MPs were expected to vote on a package that included winding up Laiki and creating a good and bad bank out of the two biggest banks, with deposits up to €100,000 insured and those higher than that being hit for much bigger sums.

There would also be emergency bills on capital controls to try to avoid a bank run and capital flight from the island if the banks reopen on Tuesday after being closed for 10 days.

European commission officials said that the legislation on restructuring Laiki and imposing capital controls had to be endorsed by the troika and then implemented virtually immediately to have a chance of meeting Monday's deadline.

Officials said that eurozone finance ministers could stage another emergency session on Sunday, either in Brussels or by teleconference.